Delta first airline to buy an oil refinery, to get control of jet fuel costs

Date added: May 1, 2012

Delta Air Lines has agreed to buy a disused oil refinery near Philadelphia from ConocoPhillips to offset the risk of higher jet fuel prices. The airline says it is just a modest investment of $150 million – about the same as buying one Boeing 777. Delta has received $30 million from the state of Pennsylvania as part of a deal to support job creation, and says it would spend $100 million more to refurbish the plant to increase its output of jet fuel. The company estimated this will cut its annual jet fuel bill by some $300 million, once the refinery was refurbished and operating again. To achieve similar fuel savings, it would have to buy 60 new-generation narrow-body planes like the Boeing 737, a capital investment that would total $2.5 billion. Delta said it had also struck a three-year agreement with BP to supply crude oil to the refinery.

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Delta aims to be seller of jet fuel

Delta Air Lines plans to become a seller in the U.S. jet fuel market and push prices lower after acquiring a refinery in Pennsylvania, the airline’s CEO Richard Anderson said Friday.

The company’s Monroe Energy subsidiary purchased the 185,000-barrel-a-day Trainer oil refinery near Philadelphia for $150 million on April 30. The world’s second-biggest airline spent about $11.8 billion last year on fuel, or 36% of Delta’s operating expenses, according to the company’s annual report.

“We’re probably the largest private purchaser of jet fuel in the United States but we don’t get to participate in the pricing function,” Anderson told reporters after the company’s annual meeting in New York. “It’s our intention to begin to participate in the pricing function and put a lot of downward pressure on the cost of refining a barrel of jet fuel.”

The Trainer refinery will produce 52,000 barrels a day of jet fuel, according to an April 30 Securities and Exchange Commission filing by the company. Delta will exchange all other products with BP and Phillips 66 for an additional 120,000 barrels a day of jet fuel in other locations around the country. The airline consumes about 210,000 barrels a day in the U.S.

A one-cent difference in the jet fuel price equals $40 million for Delta on an annual basis, said Eric Torbenson, a Delta spokesman. ConocoPhillips shut the Trainer refinery Sept. 30 and was planning to permanently shut the plant if it didn’t find a buyer within six months.

Delta Buys Refinery to Get Control of Fuel Costs

Delta Air Lines said on Monday that it had agreed to buy a refinery near Philadelphia from ConocoPhillips to offset the risk of higher jet fuel prices.

Richard Anderson, Delta’s chief, called it a modest investment.

Delta said that it would spend $150 million to acquire the Trainer refinery, which has been shuttered for six months, after receiving $30 million from the state of Pennsylvania as part of a deal to support job creation.

The airline said it would spend $100 million more to refurbish the plant to increase its output of jet fuel.

Richard H. Anderson, Delta’s chief executive, said the investment was a modest one, equivalent to the list price of a new wide-body plane like a Boeing 777. [A Boeing 777 costs something like $200 – 245 million]. The company estimated that it would reduce its annual fuel expense by $300 million, once the refinery was refurbished and operating again.

To achieve similar fuel savings, Delta would have to buy 60 new-generation narrow-body planes like the Boeing 737, a capital investment that would total $2.5 billion, according to a regulatory filing.

Delta said it had also struck a three-year agreement with BP to supply crude oil to the refinery.

As part of the deal, the details of which were not released, Delta said it would exchange gasoline, diesel and other petroleum products produced at the refinery for jet fuel from other sources like BP and Phillips 66.

Combined with the jet fuel produced at Trainer, Delta said these deals would provide 80 percent of its fuel needs in the United States. The purchase “is an innovative approach to managing our largest expense,” Mr. Anderson said in a statement.

The jet fuel bill at Delta, as at other airlines, soared in recent years as prices for crude oil increased. On average, fuel accounts for about a third of an airline’s operating costs, a share that has been rising for much of the last decade.

The International Air Transport Association estimates that the global airline industry’s fuel bill will grow by $40 billion this year, from about $177 billion in 2011.

These rising fuel costs have forced painful restructurings for airlines in recent years, helping to push many of them into bankruptcy and spurring consolidations across the industry. The airlines have set up elaborate hedging strategies to try to counter the rising fuel costs. But the hedges backfired when crude oil prices rose or fell in unexpected ways. Buying a refinery will not erase Delta’s fuel bill. The airline will still need to buy crude oil at world market prices. But in justifying the purchase, Delta said the cost of manufacturing jet fuel had risen more rapidly than crude oil costs. It also said that demand for jet fuel and diesel, both by-products of the refining process, had been rising steadily in recent years, while demand for gasoline was falling, adding to the pressure on jet fuel prices.

Last year, Delta spent $12 billion on fuel, about $3 billion more than the previous year, as oil prices rebounded from their postrecession lows. Fuel make up 40 percent of Delta’s costs.

The company said it expected the acquisition of the refinery to be completed in the first half of 2012. The airline said changes to the plant’s infrastructure were to be completed by the end of the third quarter, when jet fuel production would begin. Delta estimated that its fuel savings this year would be more than $100 million.

Analysts have been puzzled by Delta’s interest in the refinery, a notoriously difficult business that is chronically unprofitable. Despite the skepticism from oil specialists, investors seem to support Delta’s unusual approach. The company’s shares have gained more than 10 percent since the beginning of April as word of its interest in the refinery started to spread.

The Trainer refinery is on the Delaware River, midway between Philadelphia and Wilmington, Del. It has a crude oil capacity of 185,000 barrels a day, and processes mainly light, low-sulfur crude oil.

Trainer has historically been geared to the gasoline market in the Northeast. But as consumption dropped and light crude oil costs rose faster than other types of crude oil, Conoco’s plant has struggled.

Two refineries in the Philadelphia region — the Trainer refinery and Sunoco’s Marcus Hook — and one in the Virgin Islands, accounting for half of the East Coast’s refining capacity, have shut down since September.

Delta said Trainer’s jet fuel output would be 32 percent of the total daily capacity, up from its current 14 percent. Its gasoline production will drop to 43 percent, from 52 percent today, Delta said.

To assuage concerns that an airline has never owned or run a refinery, Delta said the plant would be led by executives with refining experience, including Jeffrey Warmann, who ran Murphy Oil’s refinery in Meraux, La.

Production at the refinery combined with multi-year agreements to exchange gasoline, diesel, and other refined products from the refinery for jet fuel will provide 80% of Delta’s jet fuel needs in the United States.

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Delta buys refinery, becoming first airline to make own fuel

(Reuters) – Delta Air Lines Inc will buy a Pennsylvania oil refinery from ConocoPhillips for $150 million (92 million pounds), an audacious bid to save money on fuel costs by investing in a sector shunned by many of the biggest oil firms.

Atlanta-based Delta said the first ever purchase of a refinery by an airline would allow it to cut $300 million annually from jet fuel costs, which reached $12 billion last year. It said production at the refinery along with other agreements to exchange refined products for jet fuel would provide 80% of its fuel needs in the United States.

The deal for the idled 185,000 barrel per day Trainer, Pa., refinery, which has puzzled analysts since it first surfaced last month, will come as some relief to politicians and officials, who had feared thousands of lost jobs and a potential summer spike in fuel costs if the plant was shut permanently.

And while the initial investment is no more than a wide-body jet liner, even including an additional $100 million to upgrade the plant to maximise jet fuel production, it will put Delta in the unique position of hoping that the recent rebound in refinery profit margins — normally an indication of added costs for a fuel consumer — doesn’t prove too fleeting.

While Delta will remain hostage to fluctuating crude oil costs, the facility would enable it to save on the cost of refining a barrel of jet fuel, which is currently more than $2 billion a year for Delta and has been rising in the wake of U.S. refinery shutdowns, said Delta Chief Executive Richard Anderson.

“What we’re tackling here today is the jet crack spread, which you cannot hedge in the marketplace effectively,” Anderson told reporters during a phone briefing. “It’s the fastest single growing cost in our book of expense at Delta.”

As expected, Delta will effectively outsource all the oil trading requirements for the refinery, an increasingly frequent arrangement for smaller or less-experienced operators.

But instead of JP Morga, which had been initially named as the trader last month, oil major BP will supply crude oil to be refined at the plant under a three-year agreement. And BP and former refinery owner Phillips 66 will get a share of the gasoline, diesel and refined fuel to sell, in exchange for supplying Delta with jet fuel in other locations.

It will be a familiar role for BP, which owned the plant in the 1990s before selling it to independent refiner Tosco in 1996 for $59 million, coupled with some additional assets. Tosco later merged with Phillips, which then merged with Conoco.

The refinery is expected to resume operations in the third quarter, Delta said, about a year after ConocoPhillips idled the plant as rising imported crude oil costs, a collapse in demand and tough competition from foreign refiners crushed margins.

Delta said the deal will include pipelines and other assets that will provide access to the delivery network for jet fuel reaching its Northeast operations, including its increasingly important hubs at New York’s LaGuardia and JFK airports.

Fuel costs pushed major U.S. airlines into the red for the first quarter, although oil prices have since eased from March peaks. U.S. crude traded around $105 a barrel on Monday, while Brent crude was about $119 a barrel.

CAUTIOUS RESPONSE

The deal offers a reprieve to one of two key refineries that had been earmarked for permanent closure this year unless buyers were found. Delta said it would get $30 million in state government assistance on the deal.

“This announcement means the preservation of more than 5,000 jobs at the Trainer facility and in related industries,” Pennsylvania Gov. Tom Corbett said in a statement.

But at the same time it will raise questions among oil sector analysts about whether the rush to revive one of the half-dozen East Coast facilities that has been shut in recent years may be premature given lingering questions over whether these plants can compete without access to cheap crude.

Profit margins in April rose to their highest since 2008, according to a Credit Suisse analysis, and are up more than 60 percent from the average of last year as the planned closure of some 1.5 million bpd, including two refineries in the Carribean, threatened to cut East Coast capacity to just a third of its peak in 2008. The cuts are deeper when factoring in Europe.

But in addition to Trainer, private equity fund The Carlyle Group is in talks to buy the biggest refinery in Philadelphia, potentially pulling another plant back from the brink.

The analysts at Credit Suisse say another 2.6 million bpd of refining capacity across the globe must be shut “to hit the “sweet spot” utilization level of 87 percent”.

The Delta refinery would be run by a leadership team headed by Jeffrey Warmann, who last ran Murphy Oil USA’s Meraux, Louisiana, refinery.

East Coast refineries, among the oldest and least advanced in the country, have been hammered by a series of bad turns: the 2008 recession that cut demand; the rapid injection of ethanol into the U.S. gasoline mix; tougher environmental norms; and the rise of new, more sophisticated plants in India and elsewhere.

The final blow for many has been the surge in cheap shale oil production from North Dakota and West Texas, which has handed a bounty of cut-priced crude to Midwest and Gulf rivals who are now running their plants flat-out.

WILL IT WORK?

Robert Mann, an airline consultant in Port Washington, New York, said Delta’s statement did not address how it will handle exposure to fluctuations in energy prices or refined product costs or the actual refining process costs.

“It’s clearly a very innovative approach, but I think it will be a number of years before we know whether it actually works out,” Mann said.

Delta is the world’s second-largest air carrier, behind United Continental Holdings. The airline expects the purchase to add to its earnings in the first year of operations.

Delta’s Monroe Energy LLC unit expects to close the purchase in the first half. JP Morgan Chase advised it in the purchase, Delta said.

Delta shares were little changed in extended trading after the announcement, which was widely expected.